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Virginia Mortgage News - March 31 2006 |
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Mortgage rates are in the process of crossing above 6.50% in panicky trading, and new economic reports are not the cause. Rates are going up because the Fed is pushing them up in unison with the Bank of Japan and the European Central Bank, which raises three questions: why are they going higher, how far are they going, and when are they going to do visible damage to the (global) economy?
The 10-year T-note, immobile below 4.50% during the first thirteen(!) quarter-point Fed hikes from summer 2004 through last December, began to move tick-for-tick with the Fed’s overnight cost of money in January. Fed to 4.50% on February 1, bonds to 4.50%; as this week’s Fed meeting approached, 4.75% a certainty, bonds went to 4.75%. The Fed next meets on May 10, and bonds aren’t waiting around as they did before the last two meetings: the 10-year touched 4.90% today, sure to go to 5.00% in April.
Perfesser Bernanke’s first post-meeting minutes gave no hint that 5.00% would be a pause point; mid-range optimism says 5.25% on June 29 is the best hope, which would put mortgages near 7%. 5.50% in August is possible.
The BOJ may not soon impose a cost of money (it’s been at 0% for years), but apparent economic health there will cause the BOJ to slow its flood of liquidity into the global economy. Nobody knows how much 0% yen borrowing has been used to speculate in the global bond market, but it’s been a lot; as speculators unwind, they are dumping a ton of bonds and mortgages. 10-year Japanese bonds, stuck at 1.25% or lower for a decade, are all the way to 1.75% and still moving up.
The ECB has inflation bejabbers, has taken its rate from 2% to 2.50% this year, and guesses run to at least three more .25% hikes in ’06. The German 10-year bund has departed 3.25% for 3.75%.
During the first 18 months of Fed hikes, Mr. Greenspan kept saying that he was going to “neutral.” We haven’t heard that word from the Fed since last fall. The Fed is tilting to tight against a traditional threat of economic overheating, seriously magnified by energy prices that are unlikely to enjoy a cyclical retreat, 70s- and 80s-style, and against the stimulus of low long-term rates.
The bond market opinion has been that the Fed’s hikes will hurt housing first, then rest of the economy. Some historical perspective is in order. In the 31 years from 1969 to 2000, mortgage rates fell below 7.00% only once, during a few weeks in 1998. I doubt that a rise above 7.00% will be catastrophic. In the 35 years prior to 2001, the Fed funds rate was below 5% only during the 1993 recession trough and a few months 1998-99. In 1994 the Fed raised its rate from 3% to 6%, and then backed off to 5.50% in 1995 at the dawn of one of the truly splendid economic intervals in American history. The centerline for mortgage rates then was 8%.
Housing is vulnerable because of its price overshoot in coastal regions, its conditioning to five years of free-money ARMs and HELOCS, and the abuse of innovative mortgage products. However, Even if the overheated housing markets begin to decline modestly in price, I’m not convinced that will trigger a general economic slowdown. Serial housing crashes in the mid and late 1980s (oil patch, and then Atlantic coast and New England) did not intercept a strong economy.
Although we’re in the midst of a bond-market sell panic, I think we are close to the end of the exercise, working through the surprise that the Fed will go as high as the 5.25% to 5.50% area. The Fed knows well that the economy fainted abruptly at the last two trips to 6.00%, and the BOJ and ECB know that their economic growth is slim and utterly dependent on health here.
In the meantime, before the Fed’s conclusion, try not to join the bond panic. |
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